Insurance industry profits fell 12% to $4.4 billion last financial year as catastrophes such as the Sydney hailstorms and the Townsville floods increased natural hazard costs, a KPMG annual review shows.

The combined operating ratio worsened to 92% from 88%, with the loss ratio deteriorating five percentage points to 68%. The expense ratio improved to 24% from 25%.

KPMG Head of Insurance David Kells says the figures, released today, illustrate the cyclical nature of insurance.

“The previous two years were relatively kind in terms of claims, but this year saw a less favourable claims experience for insurers, while lower than expected reserve releases added to the decline in profits,” he said.

Gross written premium (GWP) rose 5% to $44.8 billion, driven by rate rises and despite reduced compulsory third party contributions amid scheme reforms in NSW and Queensland.

KPMG Insurance Partner Scott Guse says the past few years have seen steady upward price momentum, with gains of about 4-5% in retail products such as home and motor. Similar increases are likely to be seen by insurers in the current year.

“At the same time claims costs are rising, so it is not as if they are getting all the increases to the bottom line,” he told insuranceNEWS.com.au. “But price increases are here, I think, for the next few years.”

Catastrophe costs were offset by higher reinsurance recoveries and reserve releases, mainly related to compulsory third party schemes.

The sophistication of vehicle computerised systems is boosting claims costs, while regulatory and compliance expenses have increased since the Hayne royal commission report.

“I think the regulatory costs that have been incurred this year are the new norm,” Mr Guse said. “Most of the insurers have ramped up their regulatory framework and compliance to meet new legislation before it has been enacted.”

The report shows that insurers have pursued efficiencies through automation and more cost-effective distribution, with Suncorp’s business improvement program and IAG’s optimisation program among advances flagged to the market.

Mr Guse says a drop in the insurance margin to 13.6% is a concern; it was around 16% for the previous two years.

“The dual focus on reducing costs while upgrading digital capabilities, to automate businesses and improve product offerings and enhance the customer experience, will have to be redoubled,” he said.

KPMG’s report also identifies 10 emerging trends, headed by digital demands and the need for companies to become connected enterprises across their front, middle and back offices.

Technology changes dominate the list, which also includes insurtechs, blockchain technology and the development of artificial intelligence and robotics.

Other trends highlighted are customer-centricity, climate change, cyber security, the implementation of accounting standard IFRS17, the regulatory agenda and the low interest rate environment.

Mr Guse says companies face a challenge in offsetting interest rate declines as Australian Prudential Regulation Authority rules mean higher-returning but riskier assets trigger greater capital requirements.

“It is a bit of a double-edged sword for insurers. They would prefer to have the more vanilla-type investments that give them a fixed interest return, and then they get the lower capital charge.”